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CHAPTER 7
INTERNAL RECONSTRUCTION
LEARNING OUTCOMES
After studying this chapter, you will be able to:
 Understand the meaning of term “reconstruction”.
 Sub-divide and consolidate shares.
 Convert shares into stock and stock into shares.
 Account for the adjustments made at the time of internal
reconstruction.
CHAPTER OVERVIEW
Methods of Internal
Reconstruction
Alteration Variation of Reduction
Compromise/ Surrender
of Share Shareholders’ of Share
Arrangement of Shares
Capital rights Capital
Sub-division and Conversion of share

Consolidation of into stock or vice-
Shares versa
© The Institute of Chartered Accountants of India

7. 2 ADVANCED ACCOUNTING
1. MEANING OF RECONSTRUCTION
When a company has been making losses for a number of years, the financial
position does not present a true and fair view of the state of the affairs of the
company. In such a company the assets are overvalued, the assets side of the
balance sheet consists of fictitious assets, useless intangible assets and debit
balance in the profit and loss account. Such a situation does not depict a true
picture of financial statements and shows a higher net worth than what the real
net worth ought to be. In short the company is over capitalized. Such a situation
brings the need for reconstruction.
Reconstruction is a process by which affairs of a company are reorganized by

revaluation of assets, reassessment of liabilities and by writing off the losses already
suffered by reducing the paid up value of shares and/or varying the rights attached
to different classes of shares. The object of reconstruction is usually to reorganize
capital or to compound with creditors or to effect economies. Such a process is
called internal reconstruction which is carried out without liquidating the
company and forming a new one.
However, there may be external reconstruction. Wherever an undertaking is being

carried on by a company and is in substance transferred, not to an outsider, but
to another company consisting substantially of the same shareholders with a view
to its being continued by the transferee company, there is external reconstruction.
Such external reconstruction is essentially covered under the category
‘amalgamation in the nature of merger’ in AS-14.
Difference Between Internal and External Reconstruction
Basis Internal Reconstruction External Reconstruction

Liquidation The existing company is The existing company is
not liquidated. liquidated.
Formation No new company is formed A new company is formed
but only the rights of to take over the liquidated
shareholders and creditors company.
are changed.
Reduction of There is certain reduction There is no reduction of
capital of capital and sometimes capital. In fact there is a
the outside liabilities like fresh share capital of the
debenture holders may company.
have to reduce their claim.

INTERNAL RECONSTRUCTION OF COMPANIES 7.3
Legal position Internal reconstruction is External reconstruction is

done as per provisions of regulated by section 232
section 66 of the of the Companies Act,
Companies Act, 2013. 2013.
2. METHODS OF INTERNAL RECONSTRUCTION

For properly deploying the process of internal reconstruction following methods
are generally employed or used simultaneously:
2.1 Alteration of Share Capital

Sub-division and Consolidation of Shares
If authorised by its Articles, a company may, in a general meeting by passing an
ordinary resolution, decide to sub-divide or consolidate the shares into those of a
smaller or higher denomination than that fixed by the Memorandum of
Association, so long as the proportion between the paid up and unpaid amount, if
any, on the shares continues to be the same as it was in the case of the original
shares.
A notice specifying alteration made must be given to the Registrar within 30 days
of alteration.
For example, a company with a capital of ` 10,00,000 divided into 10,000 equity
shares of ` 100 each on which ` 75 is paid up decides to recognise its capital by
splitting one equity share of ` 100 each into 10 such shares of ` 10 each. The
consequential entry to be passed in such a case would be—
Dr. Cr.
` `
Equity Share Capital (` 100) A/c Dr. 7,50,000
To Equity Share Capital (` 10) A/c 7,50,000
(Being the sub-division of 10,000 shares of ` 100
each with ` 75 paid up thereon into 1,00,000
shares of ` 10 each with ` 7.50 paid up thereon
as per the resolution of shareholders passed in
the General Meeting held on...)
Similar entries will be passed on consolidation of shares of a smaller amount into

those of a larger amount.

Illustration 1
On 31-12-20X1, B Ltd. had 20,000, ` 10 Equity Shares as authorised capital and

the shares were all issued on which ` 8 was paid up. In June, 20X2 the company in
general meeting decided to sub-divide each share into two shares of ` 5 with ` 4
paid up. In June, 20X3 the company in general meeting resolved to consolidate 20
shares of ` 5, ` 4 per share paid up into one share of ` 100 each, ` 80 paid up.
Pass entries and show how share capital will appear in notes to Balance Sheet as
on 31-12-20X1, 31-12-20X2 and 31-12-20X3.
Solution
Journal Entries
20X2 ` `
June Equity Share Capital (` 10) A/c Dr. 1,60,000
(Being the sub-division of 20,000 shares
of ` 10 each with ` 8 paid up into 40,000
shares ` 5 each with ` 4 paid up by
resolution in general meeting dated....)
20X3 Equity Share Capital (` 5) A/c Dr. 1,60,000
June To Equity Share Capital (` 100) A/c 1,60,000
(Being consolidation of 40,000 shares of
` 5 with ` 4 paid up into 2,000 ` 100
shares with ` 80 paid up)
Notes to Balance Sheet
Liabilities: `
As on 31-12-20X1
1. Share Capital
Authorised:
20,000 Equity Shares of ` 10 each 2,00,000
Issued and Subscribed:
20,000 Equity Shares of ` 10 each ` 8 per share called up 1,60,000

As on 31-12-20X2
1. Share Capital
Authorised:
As on 31-12-20X3 `
1. Share Capital
Authorised:
Note: Some accountants prefer not to make any entry as the amount remains
same. Even when an entry is passed it applies only to the called up portion, and
not to uncalled or unissued portion of share capital.
Conversion of Fully Paid Shares into Stock and Stock into Shares
According to section 61 of Companies Act, 2013, a company can convert its fully
paid shares into stock and reconversion of stock into shares. If authorised by its
Articles, a company may, in a general meeting by passing an ordinary resolution,
can convert its fully paid shares into stock and reconversion of stock into shares.
Stock is the consolidation of the share capital into one unit divisible into aliquot
parts. Stock is a bundle of fully paid shares put together for convenience so that it
may be divided into any amount and transferred into any fractions and sub-
divisions without regard to the original face value of the shares. While it is
impossible for share capital to be one share, any amount of stock may be
transferred. In practice, however, companies restrict the transfer of stock to
multiples say, ` 100. A company can convert its fully paid shares into stock. Upon
the company converting its shares into stock, the book-keeping entries merely
record the transfer from share capital account to stock account. A separate Stock
Register is started in which details of members’ holdings are entered and the
annual return is modified accordingly.

Illustration 2
C Ltd. had ` 5,00,000 authorised capital on 31-12-20X1 divided into shares of ` 100
each out of which 4,000 shares were issued and fully paid up. In June 220X2 the
Company decided to convert the issued shares into stock. But in June, 20X3 the
Company re-converted the stock into shares of ` 10 each, fully paid up.
Pass entries and show how Share Capital will appear in Notes to Balance Sheet as
on 31-12-20X1, 31-12-20X2 and 31-12-20X3.
Solution
Journal Entries
20X2 ` `
June Equity Share Capital A/c Dr. 4,00,000
To Equity Stock A/c 4,00,000
(Being conversion of 4,000 fully paid
Equity Shares of ` 100 into ` 4,00,000
Equity Stock as per resolution in
general meeting dated…)
20X3
June Equity Stock A/c Dr. 4,00,000
To Equity Share Capital A/c 4,00,000
(Being re-conversion of ` 4,00,000
Equity Stock into 40,000 shares of ` 10
fully paid Equity Shares as per
resolution in General Meeting dated...)
Notes to Balance Sheet
Liabilities :
As on 31-12-20X1 `
1. Share Capital
Authorised
Issued and Subscribed
4,000 Equity Shares of ` 100 each fully called up 4,00,000

As on 31-12-20X2 `
1. Share Capital
Authorised
Equity Stock-4,000 Equity Shares of ` 100 converted into Stock 4,00,000
As on 31-12-20X3 `
1. Share Capital
Authorised
40,000 Equity Shares of ` 10 each fully called up 4,00,000
2.2 Variation of Shareholders Rights

Section 48 of the Companies Act, 2013 provides that when a company has issued
different classes of shares with different rights or privileges attached to such
shares e.g. rights as to dividend, voting rights etc., any of such right may be
changed in any manner. It happens with the consent in writing of the holders of
not less than three-fourths of the issued shares of that class or by means of a
special resolution passed at a separate meeting of the holders of the issued
shares of that class, (a) if provision with respect to such variation is contained in
the memorandum or articles of the company; or (b) in the absence of any such
provision in the memorandum or articles, if such variation is not prohibited by the
terms of issue of the shares of that class, provided that if variation by one class of
shareholders affects the rights of any other class of shareholders, the consent of
three-fourths of such other class of shareholders shall also be obtained and the
provisions of this section shall apply to such variation.
For example, the company may change rate of (a) dividend on preference shares
or (b) convert cumulative preference shares into non-cumulative preference
shares without changing the amount of share capital by passing the following
journal entries:
(a) Debit (Old)% Cum. Pref. Share Capital Account
Credit (New)% Cum. Pref. Share Capital Account

(b) Debit …% Cum. Pref. Share Capital Account

Credit …% Non-cum. Pref. Share Capital Account
2.3 Reduction of Share Capital
Section 66 of the Companies Act, 2013 lays down the procedure in respect of
reduction of share capital. Subject to confirmation by the Tribunal on an
application by the company, a company may, by a special resolution, reduce the
share capital in the following manner-
(a) Extinguishing or reducing the liability of the shareholders in respect of
unpaid amount on the shares held by them; or
(b) Paying off any paid-up share capital which is in excess of its requirements;
(c) Cancelling any paid-up share capital which is lost or is unrepresented by
available assets.
Generally reduction in share capital is followed when a company has been
suffering losses continuously for a long time, is not truly represented by its assets.
In such a case, any scheme for capital reduction should write-off that portion of
capital which is already lost.
This reduction is a sacrifice by the shareholders and the amount of reduction or

sacrifice is credited to a new account called Capital Reduction Account (or
Reconstruction Account). The accounting treatment is as follows:
(a) When liability of the shareholders is extinguished or reduced in respect
of unpaid amount on the shares held by them: Here the shareholders are not
called upon to pay the unpaid amount on shares held by them in future. For
example, a company decides to reduce ` 10 per share, into ` 7.5 per share fully
paid up, by cancelling the unpaid amount of ` 2.5 per share. The entry in this case
would be
Share Capital (Partly Paid-Up) Account Dr. (` 7.5 X No. of Shares)
To Share Capital (Fully Paid-up) Account (` 7.5 X No. of Shares)
(b) When excess paid up capital is paid off: When its not possible for the
company to employ profitability its paid up capital, then in such case it may
decide to refund the excess capital to its shareholders. For example, a company
having fully paid-up share of ` 10 each, decides to pay-off ` 2 per share to make
it of ` 8 fully paid-up, entries in that case would be

Share Capital Account (` 10 ) Dr. (` 10 X No. of Shares)

To Share Capital Account (` 8 ) (` 8 X No. of Shares)
To Sundry Shareholders Account (` 2 X No. of Shares)
Sundry Shareholders Account Dr. (` 2 X No. of Shares)
To Bank Account (` 2 X No. of Shares)
(c) When the paid up capital which is lost or not represented is cancelled:
Reduction in paid up value only- Here the nominal value of the share remains the
same and only the paid value is reduced. For example, the shareholders may agree to
reduce the paid capital of ` 100 per share to paid value of ` 10 per share. The
sacrifice is ` 90 and the entry will be
Share Capital Account Dr. (` 90 X No. of Shares)

To Capital Reduction Account (` 90 X No. of Shares)
Reduction in both nominal and paid up values- In this case, both the paid up
capital and nominal value of the shares are reduced. Continuing the above
example, the entry will be:
Share Capital Account (` 100 Share) Dr. (` 100 X No. of Shares)
To Share Capital (` 10 Share) (` 10 X No. of Shares)
To Capital Reduction Account (` 90 X No. of Shares)
Thus in such treatment we debit the original Share Capital Account so as to close
it, credit new Share Capital Account with the amount treated as paid up; and
credit Capital Reduction Account with the difference. A certified copy of Court’s
order and Minutes approved by the Court must be filed by the Registrar.
2.4 Compromise/Arrangements
A scheme of compromise and arrangement is an agreement between a company
and its members and outside liabilities when the company faces financial
problems. Such an arrangement therefore also involves sacrifices by shareholders,
or creditors and debenture holders or by all.
Accounting treatment for some of the cases is as follows:

a) When equity shareholders give up there claim to reserves and accumulated
profits:
Reserves Account Dr. (With the amount of
To Reconstruction Account reserves)

b) Settlement of outside liabilities at lesser amount: Liabilities such as sundry

creditors may agree to accept less amount in lieu of final settlement.
Treatment will be as follows:
Outside Liabilities Account Dr. (With the amount of sacrifice)
Provision Account, if any Dr. made by creditors,
debenture
To Reconstruction Account holders etc.)
2.5 Surrender of Shares

In this method, shares are divided intoshares of smaller denominations and then
the shareholders are made to surrender their shares to the company. These shares
are then allotted to debenture holders and creditors so that their liabilities are
reduced. The unutilized surrendered shares are then cancelled by transeferred to
Reconstruction Account.
Note : The problems involving the above methods of Internal reconstruction have
been given after Para 3 on” Entries in case of Internal Reconstruction””
3. ENTRIES IN CASE OF INTERNAL RECONSTRUCTION

On a scheme of reconstruction being adopted (through special resolution
confirmed by the Court), the entries to be passed are:
1. An appreciation in the value of an asset or reduction in the amount of a
liability should be debited to the account concerned and credited to Capital
Reduction Account (or Reconstruction Account).
2. Write off all fictitious assets (including Goodwill and Patents) and eliminate
all over-valuation of assets by crediting the accounts concerned and
debiting the Capital Reduction (or Reconstruction) Account. For this
purpose, any reserve appearing in the books of the company may be used.
If any balance is left in the Capital Reduction (or Reconstruction) Account it
should be transferred to the Capital Reserve Account.
While preparing the balance sheet of a reconstructed company, the following
points are to be kept in mind:
(a) After the name of the company, the words “and Reduced” should be added
only if the Court so orders.
(b) In case of fixed assets, the amount written off under the scheme of
reconstruction must be shown for five years.
Illustration 3
The Balance Sheet of A & Co. Ltd. as on 31-12-20X1 is as follows:
Assets ` `
Fixed Assets:
Freehold property 4,25,000
Plant 50,000
Patent 37,500
Goodwill 1,30,000 6,42,500
Traded Investments (at cost) 55,000
Current Assets:
Trade receivables 4,85,000
Inventory 4,25,000 9,10,000
Profit and Loss Account 5,35,000
Total 21,42,500
Liabilities
Share Capital:
4,000 6% Cumulative Preference Shares of ` 100 4,00,000
each
75,000 Equity Shares of ` 10 each 7,50,000 11,50,000
6% Debentures (Secured on Freehold Property) 3,75,000
Accrued Interest 22,500 3,97,500
Current Liabilities:
Bank Overdraft 1,95,000
Trade payables 3,00,000
Directors’ Loans 1,00,000 5,95,000
Total 21,42,500
The Court approved a Scheme of re-organisation to take effect on 1-1-20X1,

whereby:
(i) The Preference shares to be written down to ` 75 each and Equity Shares to ` 2
each.

(ii) Of the Preference Share dividends which are in arrears for four years, three
fourths to be waived and Equity Shares of ` 2 each to be allotted for the
remaining quarter.
(iii) Accrued interest on debentures to be paid in cash.
(iv) Debenture-holders agreed to take over freehold property, book value `
1,00,000 at a valuation of ` 1,20,000 in part repayment of their holdings and
to provide additional cash of ` 1,30,000 secured by a floating charge on
company’s assets at an interest rate of 8% p.a.
(v) Patents and Goodwill to be written off.
(vi) Inventory to be written off by ` 65,000.
(vii) Amount of ` 68,500 to be provided for bad debts.
(viii) Remaining freehold property to be re-valued at ` 3,87,500.
(ix) Trade Investments be sold for ` 1,40,000.
(x) Directors to accept settlement of their loans as to 90% thereof by allotment of
equity shares of ` 2 each and as to 5% in cash, and balance 5% being waived.
(xi) There were capital commitments totalling ` 2,50,000. These contracts are to be
cancelled on payment of 5% of the contract price as a penalty.
(xii) Ignore taxation and cost of the scheme.
You are requested to show Journal entries reflecting the above transactions
(including cash transactions) and prepare the Balance Sheet of the company after
completion of the Scheme.
Solution
Journal of A & Co. Ltd.
Dr. Cr.
` `
20X1 Equity Share Capital A/c (` 10) Dr. 7,50,000
Dec. 31 To Capital Reduction A/c 6,00,000
To Equity Share Capital A/c (` 2) 1,50,000
(Reduction of equity shares of ` 10 each to
shares of ` 2 each as per Reconstruction
Scheme dated...)

6% Cum. Preference Share Capital A/c Dr. 4,00,000

(` 100)
To Capital Reduction A/c 1,00,000
To Pref. Share Capital A/c (` 75) 3,00,000
(Reduction of preference shares of ` 100
each to shares of ` 75 each as per
reconstruction scheme)
20X1 Freehold Property A/c Dr. 82,500
Dec. 31 To Capital Reduction A/c 82,500
(Appreciation in the value of property:
Book value Revalued Figure
` 1,00,000 ` 1,20,000
` 3,25,000 ` 3,87,500
Total ` 4,25,000 ` 5,07,500
Profit on revaluation: ` 82,500)
” 6% Debentures A/c Dr. 1,20,000
To Freehold Property A/c 1,20,000
(Claims of debenture-holders, in part, in
respect of principal discharged by transfer
of freehold property vide Scheme of
Reconstruction)
Accrued Interest A/c Dr. 22,500
To Bank A/c 22,500
(Debenture interest paid)
” Bank A/c Dr. 1,30,000
To 8% Debentures A/c 1,30,000
(8% Debentures issued for cash)
” Bank A/c Dr. 1,40,000
To Trade Investment A/c 55,000
To Capital Reduction A/c 85,000
(Sale of Trade Investment for ` 1,40,000 cost
being ` 55,000; profit credited to Capital
Reduction Account)
” Directors’ Loan A/c Dr. 1,00,000
To Equity Share Capital A/c 90,000

To Bank A/c 5,000
(Directors’ loan discharged by issue of
equity shares of ` 90,000, cash payments of
` 5,000 and surrender of ` 5,000, vide
Scheme of Reconstruction)
Dec. 31 Capital Reduction Account Dr. 24,000
To Equity Share Capital Account 24,000
(Arrears of preference dividends satisfied by
the issue of equity shares, 25% of the amount
due, ` 96,000)
” Capital Reduction A/c Dr. 8,48,500
To Patents 37,500
To Goodwill 1,30,000
To Inventory 65,000
To Provision for Doubtful Debts 68,500
To Bank 12,500
To Profit & Loss Account 5,35,000
(Writing off patents, goodwill, profit and
loss account and reducing the value of
stock, making the required provision for
doubtful debts and payment for
cancellation of capital commitments)
Balance Sheet of A & Co. Ltd. (And Reduced) as on 1st January, 20X2
Particulars Notes `
Equity and Liabilities
1 Shareholders’ funds
a Share capital 1 5,64,000
2 Non-current liabilities
a Long-term borrowings 2 3,85,000
3 Current liabilities
a Trade Payables 3,00,000

b Short term provision 3 68,500

Total 13,17,500
Assets
1 Non-current assets
a Fixed assets
Tangible assets 4 4,37,500
Intangible assets 5 -
2 Current assets
a Inventories 3,60,000
b Trade receivables 6 4,85,000
c Cash and cash equivalents 35,000
Total 13,17,500
Notes to accounts
1 Share Capital
Equity share capital
1,32,000 Equity shares of ` 2 each (of the above 2,64,000
45,000 shares have been issued for
consideration other than cash)
Preference share capital
4,000 6% Preference shares of ` 75 each 3,00,000
Total 5,64,000
2 Long-term borrowings
Secured
6% Debentures 2,55,000
Total 3,85,000
3 Short term provision
Provision for doubtful debt 68,500
4 Tangible assets
Fixed assets

Tangible assets
Freehold property 4,25,000
Add: Appreciation under scheme of
Reconstruction 82,500
Less: Disposed of (1,20,000) 3,87,500
Plant 50,000
Patents 37,500
Less: Written off under scheme of
Reconstruction (37,500) -
Net carrying value 4,37,500
5 Intangible assets
Goodwill 1,30,000
Less: Written off under scheme of (1,30,000)
Reconstruction
Net carrying value - -
6 Trade receivables
Trade receivables 4,85,000
Illustration 4
Given below is the summarized balance sheet of Rebuilt Ltd. as on 31.3.20X1:
Liabilities Amount Assets Amount
` `
Authorised and issued capital: Building at cost
12,000, 7% Preference shares of ` less depreciation 4,00,000
50 each (Note: Preference 6,00,000 Plant at cost less 2,68,000
dividend is in arrear for five depreciation
years)
15,000 Equity shares of ` 50 each 7,50,000 Trademarks and
13,50,000 goodwill at cost 3,18,000
Loan 5,73,000 Inventory 4,00,000
Trade payables 2,07,000 Trade receivables 3,28,000
Other liabilities 35,000 Profit and loss A/c 4,51,000
21,65,000 21,65,000

The Company is now earning profits short of working capital and a scheme of
reconstruction has been approved by both the classes of shareholders. A summary
of the scheme is as follows:
(a) The equity shareholders have agreed that their ` 50 shares should be reduced
to ` 2.50 by cancellation of ` 47.50 per share. They have also agreed to
subscribe for three new equity shares of ` 2.50 each for each equity share held.
(b) The preference shareholders have agreed to cancel the arrears of dividends and
to accept for each ` 50 share, 4 new 5% preference shares of ` 10 each, plus 6
new equity shares of ` 2.50 each, all credited as fully paid.
(c) Lenders to the company for ` 1,50,000 have agreed to convert their loan into
share and for this purpose they will be allotted 12,000 new preference shares of
` 10 each and 12,000 new equity shares of ` 2.50 each.
(d) The directors have agreed to subscribe in cash for 40,000, new equity shares of
` 2.50 each in addition to any shares to be subscribed by them under (a) above.
(e) Of the cash received by the issue of new shares, ` 2,00,000 is to be used to
reduce the loan due by the company.
(f) The equity share capital cancelled is to be applied:
i. to write off the debit balance in the profit and loss A/c; and
ii. to write off ` 35,000 from the value of plant.
Any balance remaining is to be used to write down the value of trademarks and
goodwill.
Show by journal entries how the financial books are affected by the scheme and
prepare the balance sheet of the company after reconstruction. The nominal capital
as reduced is to be increased to ` 6,50,000 for preference share capital and `
7,50,000 for equity share capital.
Solution
In the books of Rebuilt Ltd.
Journal Entries
Particulars Debit Credit

(` ) (` )
1. Equity share capital A/c (` 50) Dr. 7,50,000
To Equity share capital A/c (` 2.50) 37,500

To Capital reduction A/c 7,12,500

(Being equity capital reduced to nominal value
of ` 2.50 each)
2. Bank A/c Dr. 1,12,500
To Equity share capital 1,12,500
(Being 3 right shares against each share was
issued and subscribed)
3. 7% Preference share capital A/c (` 50) Dr. 6,00,000
Capital reduction A/c Dr. 60,000
To 5% Preference share capital (` 10) 4,80,000
To equity share capital (` 50) 1,80,000
(Being 7% preference shares of ` 50 each
converted to 5% preference shares of ` 10 each
and also given to them 6 equity shares for every
share held)
4. Loan A/c Dr. 1,50,000
To 5% Preference share capital A/c 1,20,000
To Equity share capital A/c 30,000
(Being loan to the extent of ` 1,50,000 converted
into share capital)
5. Bank A/c Dr. 1,00,000
To Equity share application money A/c 1,00,000
(Being shares subscribed by the directors)
6. Equity share application money A/c Dr. 1,00,000
To Equity share capital A/c 1,00,000
(Being application money transferred to capital
A/c)
7. Loan A/c Dr. 2,00,000
To Bank A/c 2,00,000
(Being loan repaid)
8. Capital reduction A/c Dr. 6,52,500
To Profit and loss A/c 4,51,000
To Plant A/c 35,000

To Trademarks and Goodwill A/c (Bal.fig.) 1,66,500
(Being losses and assets written off to the extent
required)
Balance sheet of Rebuilt Ltd. (and reduced)

as on 31.3.20X1
Particulars Notes `
1 Shareholders' funds
a Long-term borrowings 2,23,000
b Other current liabilities 35,000
Total 15,25,000
Assets
a Fixed assets
Intangible assets 3 1,51,500
2 Current assets
a Inventories 4,00,000
b Trade receivables 3,28,000
c Cash and cash equivalents 4 12,500
Total 15,25,000
Notes to accounts
`
1 Share Capital
Authorised capital:
65,000 Preference shares of ` 10 each 6,50,000

3,00,000 Equity shares of ` 2.50 each 7,50,000 14,00,000
Issued, subscribed and paid up:
1,80,000 equity shares of ` 2.5 each 4,60,000
60,000, 5% Preference shares of ` 10 each 6,00,000 10,60,000
2 Tangible assets
Building at cost less depreciation 4,00,000
Plant at cost less depreciation 2,33,000 6,33,000
3. Intangible assets
Trademarks and goodwill 1,51,500
4 Cash and cash equivalents
Bank (1,12,500+1,00,000-2,00,000) 12,500
Illustration 5
Repair Ltd. is in the hands of a receiver for debenture holders who holds a charge
on all assets except uncalled capital. The following statement shows the position as
regards creditors as on 30 th June, 20X1:
Liabilities ` Assets `
6,000 shares of ` 60 each, Property, machinery
` 30 paid up and plant etc. (Cost
First debentures 3,00,000 ` 3,90,000)
Second debentures 6,00,000 Estimated at 1,50,000
Unsecured trade payables 4,50,000 Cash in hand of
the receiver 2,70,000
Charged under debentures 4,20,000
Uncalled capital 1,80,000
6,00,000
Deficiency 7,50,000
13,50,000 13,50,000
A holds the first debentures for ` 3,00,000 and second debentures for ` 3,00,000.
He is also an unsecured creditor for ` 90,000. B holds second debentures for
` 3,00,000 and is an unsecured trade payables for ` 60,000.

The following scheme of reconstruction is proposed:

1. A is to cancel ` 2,10,000 of the total debt owing to him, to bring ` 30,000 in
cash and to take first debentures (in cancellation of those already issued to
him) for ` 5,10,000 in satisfaction of all his claims.
2. B is to accept ` 90,000 in cash in satisfaction of all claims by him.
3. In full settlement of 75% of the claim, unsecured creditors (other than A and B)
agreed to accept four shares of ` 7.50 each, fully paid against their claim for
each share of ` 60. The balance of 25% is to be postponed and to be payable
at the end of three years from the date of Court’s approval of the scheme. The
nominal share capital is to be increased accordingly.
4. Uncalled capital is to be called up in full and ` 52.50 per share cancelled, thus
making the shares of ` 7.50 each.
Assuming that the scheme is duly approved by all parties interested and by the
Court, give necessary journal entries.
Solution
Journal Entries
Particulars Debit Credit

(` ) (` )
First debentures A/c Dr. 3,00,000
Second debentures A/c Dr. 3,00,000
Unsecured creditors A/c Dr. 90,000
To A’s A/c 6,90,000
(Being A’s total liability ascertained)
A’s A/c Dr. 2,10,000
(Being cancellation of debt upto ` 2,10,000)
Bank A/c Dr. 30,000
To A’s A/c 30,000
(Being cash received in course of settlement)
A’s A/c Dr. 5,10,000
To First debentures A/c 5,10,000
(Being liability of A, discharged against first
debentures)
Second debentures A/c Dr. 3,00,000

Unsecured creditors A/c Dr. 60,000
To B’s A/c 3,60,000
(Being B’s liability ascertained)
B’s A/c Dr. 3,60,000
To Bank A/c 90,000
(Being B’s liability discharged)
Unsecured trade payables A/c Dr. 3,00,000
To Equity share capital A/c 1,12,500
To Loan (Unsecured) A/c 75,000
(Being settlement of unsecured creditors)
Share call A/c Dr. 1,80,000
To Share capital A/c 1,80,000
(Being final call money due)
Bank A/c Dr. 1,80,000
To Share call A/c 1,80,000
(Being final call money received)
Share capital A/c (Face value ` 60) Dr. 3,60,000
To Share capital (Face value ` 7.50) 45,000
(Being share capital reduced to ` 7.50 each)
Capital reduction A/c Dr. 8,70,000
(Being reconstruction surplus used to write off
losses)
Working Notes:
1. Settlement of claim of remaining unsecured creditors `
75% of ` 3,00,000 2,25,000

Considering their claim for share of ` 60 each

2,25,000/60 =3,750 shares

Less: Number of shares to be issued
3,750 x 4= 15,000 shares of ` 7.5 each
Total value= 15,000 x 7.50 (1,12,500)
Transferred to Capital reduction A/c 1,12,500
2. Ascertainment of profit and loss account’s debit balance at the time of

reconstruction.
` `
Asset
Fixed assets 3,90,000
Cash 2,70,000 6,60,000
Less: Capital & Liabilities:
Share capital 1,80,000
1st Debenture 3,00,000
2nd Debenture 6,00,000
Unsecured trade payables 4,50,000 (15,30,000)
Profit and loss A/c (Debit balance) (8,70,000)
Illustration 6
The Balance Sheet of Vaibhav Ltd. as on 31st March 20X1 is as follows:
Equity Shares of ` 100 each 2,00,00,000 Fixed Assets 2,50,00,000
Investments
6%, Cumulative Preference
1,00,00,000 (Market Value 20,00,000
Shares of ` 100 each
` 19,00,000)
5% Debentures of ` 100 each 80,00,000 Current Assets 2,00,00,000
Sundry Creditors 1,00,00,000 P & L A/c 12,00,000
Provision for taxation 2,00,000
TOTAL 4,82,00,000 TOTAL 4,82,00,000

The following scheme of Internal Reconstruction is sanctioned:

(i) All the existing equity shares are reduced to ` 40 each.
(ii) All preference shares are reduced to ` 60 each.
(iii) The rate of Interest on Debentures increased to 6%. The Debenture holders
surrender their existing debentures of ` 100 each and exchange the same for
fresh debentures of ` 70 each for every debenture held by them.
(iv) Fixed assets are to be written down by 20%.
(v) Current assets are to be revalued at ` 90,00,000.
(vi) Investments are to be brought to their market value.
(vii) One of the creditors of the company to whom the company owes
` 40,00,000 decides to forgo 40% of his claim. The creditor is allotted with
60000 equity shares of ` 40 each in full and final settlement of his claim.
(viii) The taxation liability is to be settled at ` 3,00,000.
(ix) It is decided to write off the debit balance of Profit & Loss A/c.
Pass journal entries and show the Balance Sheet of the company after giving effect
to the above.
Solution
Journal Entries in the books of Vaibhav Ltd.

` `
(i) Equity share capital (` 100) A/c Dr. 2,00,00,000
To Capital Reduction A/c 1,20,00,000
(Being conversion of equity share capital of
` 100 each into `40 each as per reconstruction
scheme)
(ii) 6% Cumulative Preference Share capital 1,00,00,000
(` 100) A/c Dr.
To 6% Cumulative Preference Share 60,00,000
Capital (` 60)A/c
(Being conversion of 6% cumulative preference
shares capital of ` 100 each into
` 60 each as per reconstruction scheme)
(iii) 5% Debentures (` 100) A/c Dr. 80,00,000

To 6% Debentures (` 70) A/c 56,00,000
(Being 6% debentures of ` 70 each issued to
existing 5% debenture holders. The balance
transferred to capital reduction account as per
(iv) Sundry Creditors A/c Dr. 40,00,000
(Being a creditor of ` 40,00,000 agreed to
surrender his claim by 40% and was allotted
60,000 equity shares of ` 40 each in full
settlement of his dues as per reconstruction
scheme)
(v) Provision for Taxation A/c Dr. 2,00,000
Capital Reduction A/c Dr. 1,00,000
To Liability for Taxation A/c 3,00,000
(Being conversion of the provision for taxation
into liability for taxation for settlement of the
amount due)
(vi) Capital Reduction A/c Dr. 199,00,000
To P & L A/c 12,00,000
To Fixed Assets A/c 50,00,000
To Current Assets A/c 110,00,000
To Investments A/c 1,00,000
To Capital Reserve A/c (Bal. fig.) 26,00,000
(Being amount of Capital Reduction utilized in
writing off P & L A/c (Dr.) Balance, Fixed Assets,
Current Assets, Investments and the Balance
transferred to Capital Reserve)
(vii) Liability for Taxation A/c Dr. 3,00,000
To Current Assets (Bank A/c) 3,00,000
(Being the payment of tax liability)

Balance Sheet of Vaibhav Ltd. (After Reconstruction) as on 31 st March, 20X1

Particulars Notes `
b Reserves and Surplus 2 26,00,000
Long-term borrowings 3 56,00,000
Trade Payables (1,00,00,000 less 40,00,000) 60,00,000
Total 3,06,00,000
Assets
a Fixed assets
b Investments 5 19,00,000
2 Current assets 6 87,00,000
Total 3,06,00,000
Notes to accounts
`
1. Share Capital
Issued, subscribed and paid up
2,60,000 equity shares of ` 40 each
(of the above 60,000 shares have been 1,04,00,000
issued for consideration other than cash)
1,00,000 6% Cumulative Preference shares of
60,00,000
` 60 each
Total 1,64,00,000

2. Reserves and Surplus

Capital Reserve 26,00,000
3. Long-term borrowings
Secured
4. Tangible assets
Fixed Assets 2,50,00,000
Adjustment under scheme of reconstruction (50,00,000) 2,00,00,000
5. Investments 20,00,000
Adjustment under scheme of reconstruction (1,00,000) 19,00,000
6. Current assets
Adjustment under scheme of reconstruction 2,00,00,000
110,00,000
Taxation liability paid 90,00,000
(3,00,000) 87,00,000
Working Note:
Capital Reduction Account
To Liability for taxation A/c 1,00,000 By Equity share 1,20,00,000

capital
To P & L A/c 12,00,000 By 6% Cumulative
preferences
To Fixed Assets 50,00,000 Share capital 40,00,000
To Current assets 1,10,00,000 By 5% Debentures 24,00,000
To Investment 1,00,000 By Sundry creditors 16,00,000
To Capital Reserve (Bal.
fig.) 26,00,000
2,00,00,000 2,00,00,000
Illustration 7
Following is the Summary Balance Sheet of ABC Ltd. as at 31st March, 20X1:
Share capital: Plant and machinery 9,00,000
2,00,000 Equity shares of Furniture and fixtures 2,50,000

` 10 each fully paid up 20,00,000 Patents and copyrights 70,000
6,000 8% Preference Investments (at cost) 68,000
shares of ` 100 each 6,00,000 (Market value ` 55,000)
9% Debentures 12,00,000 Inventory 14,00,000
Bank overdraft 1,50,000 Trade receivables 14,39,000
Trade payables 5,92,000 Cash and bank balance 10,000
Profit and Loss A/c 4,05,000
45,42,000 45,42,000
The following scheme of reconstruction was finalised:

(i) Preference shareholders would give up 30% of their capital in exchange for
allotment of 11% Debentures to them.
(ii) Debentureholders having charge on plant and machinery would accept plant
and machinery in full settlement of their dues.
(iii) Inventory equal to ` 5,00,000 in book value will be taken over by trade
payables in full settlement of their dues.
(iv) Investment value to be reduced to market price.
(v) The company would issue 11% Debentures for ` 3,00,000 and augment its
working capital requirement after settlement of bank overdraft.
Pass necessary Journal Entries in the books of the company. Prepare Capital
Reduction account and Balance Sheet of the company after internal reconstruction.
Solution
In the Books of ABC Ltd.
Journal Entries
Particulars ` `
8% Preference share capital A/c Dr. 6,00,000
To Preference shareholders A/c 4,20,000
[Being 30% reduction in liability of preference share
capital]
Preference shareholders A/c Dr. 4,20,000
[Being the issue of debentures to preference
shareholders]
9% Debentures A/c Dr. 12,00,000

To Debenture holders A/c 12,00,000
[Being transfer of 9% debentures to debenture
holders A/c]
Debenture holders A/c Dr. 12,00,000
To Plant & machinery A/c 9,00,000
[Settlement of debenture holders by allotment of
plant & machinery]
Trade payables A/c Dr. 5,92,000
To Inventory A/c 5,00,000
To Capital reduction A/c 92,000
[Being settlement of creditors by giving Inventories]
Bank A/c Dr. 3,00,000
[Being fresh issue of debentures]
Bank overdraft A/c Dr. 1,50,000
To Bank A/c 1,50,000
[Being settlement of bank overdraft]
Capital reduction A/c Dr. 5,72,000
To Investment A/c 13,000
To Capital reserve A/c 1,54,000
[Being decrease in investment and profit and loss
account (Dr. bal.); and balance of capital reduction
account transferred to capital reserve]
` `
To Investments A/c 13,000 By Preference share 1,80,000
capital A/c
To Profit and loss A/c 4,05,000 By 9% Debenture holders 3,00,000
A/c
To Capital reserve A/c 1,54,000 By Trade payables A/c 92,000
5,72,000 5,72,000

Balance Sheet of ABC Ltd. (And Reduced)

As on 31st March 20X1
Particulars Note No `
I. Equity and Liabilities
(1) Shareholder's Funds
(a) Share Capital 1 20,00,000
(b) Reserves and Surplus 2 1,54,000
(2) Non-Current Liabilities
(a) Long-term borrowings 3 7,20,000
Total 28,74,000
II. Assets
(1) Non-current assets
(a) Fixed assets 4
Tangible assets 2,50,000
Intangible assets 70,000
(b) Non-current investments 5 55,000
(2) Current assets
(a) Current investments
(b) Inventories (` 14,00,000 – ` 5,00,000) 9,00,000
(c) Trade receivables 14,39,000
(d) Cash and cash equivalents
Cash at Bank (W. N.) 1,60,000
Total 28,74,000
Notes to Accounts
`
1. Share Capital
2,00,000 Equity shares of ` 10 each fully paid-up 20,00,000
2. Reserve and Surplus
Capital Reserve 1,54,000
3. Long Term Borrowings
11% Debentures (` 4,20,000 + ` 3,00,000) 7,20,000

4. Fixed Assets
(i) Tangible assets
Plant & machinery 9,00,000
Less: Adjustment on scheme of reconstruction
dated 9,00,000 -
Furniture & fixtures 2,50,000
(ii) Intangible assets
Patents & copyrights 70,000
3,20,000
5. Non Current Investments
Investments (` 68,000 – ` 13,000) 55,000
Working Note:
Cash at bank = Opening balance + 11% Debentures issued – Bank overdraft paid
= ` 10,000 + ` 3,00,000 – ` 1,50,000 = ` 1,60,000
Illustration 8
The Summarised Balance Sheet of Revise Limited as at 31st March, 20X1 was as
follows :
Authorised and subscribed capital: Fixed Assets :
10,000 Equity shares of Machineries 1,00,000
` 100 each fully paid 10,00,000 Current assets :
Unsecured Loans : Inventory 3,20,000
12% Debentures 2,00,000 Trade receivables 2,70,000
Accrued interest 24,000 Bank 30,000
Current liabilities Profit and loss account 6,00,000
Trade payables- 72,000
Provision for income tax 24,000
13,20,000 13,20,000
It was decided to reconstruct the company for which necessary resolution was
passed and sanctions were obtained from appropriate authorities. Accordingly, it
was decided that:
(a) Each share is sub-divided into ten fully paid up equity shares of ` 10 each.

(b) After sub-division, each shareholder shall surrender to the company 50% of his
holding, for the purpose of re-issue to debenture holders and trade payables as
necessary.
(c) Out of shares surrendered, 10,000 shares of ` 10 each shall be converted into
12% preference shares of ` 10 each, fully paid up.
(d) The claims of the debenture-holders shall be reduced by 75 per cent. In
consideration of the reduction, the debenture holders shall receive preference
shares of ` 1,00,000 which are converted out of shares surrendered.
(e) Trade payables claim shall be reduced to 50 per cent, it is to be settled by the
issue of equity shares of ` 10 each out of shares surrendered.
(f) Balance of profit and loss account to be written off.
(g) The shares surrendered and not re-issued shall be cancelled.
You are required to show the journal entries giving effect to the above and the resultant
Balance Sheet.
Solution
Dr. Cr.
` `
Equity Share Capital (` 100) A/c Dr. 10,00,000
To Share Surrender A/c 5,00,000
(Subdivision of 10,000 equity shares of ` 100 each
into 1,00,000 equity shares of ` 10 each and
surrender of 50,000 of such subdivided shares as
per capital reduction scheme)
12% Debentures A/c Dr. 1,50,000
Accrued Interest A/c Dr. 18,000
To Reconstruction A/c 1,68,000
(Transferred 75% of the claims of the
debentureholders to reconstruction account in
consideration of which 12% preference shares are
being issued out of share surrender account as per
capital reduction scheme)

Trade payables A/c Dr. 72,000

To Reconstruction A/c 72,000
(Transferred claims of the trade payables to
reconstruction account, 50% of which is being clear
reduction and equity shares are being issued in
consideration of the balance)
Share Surrender A/c Dr. 5,00,000
To 12% Preference Share Capital A/c 1,00,000
To Equity Share Capital A/c 36,000
To Reconstruction A/c 3,64,000
(Issued preference and equity shares to discharge
the claims of the debenture holders and the trade
payables respectively as a per scheme and the
balance in share surrender account is being
transferred to reconstruction account)
Reconstruction A/c Dr. 6,04,000
To Profit and Loss A/c 6,00,000
To Capital Reserve A/c 4,000
(Adjusted debit balance of profit and loss account
against the reconstruction account and the balance
in the latter is being transferred to capital reserve)
Balance Sheet of Revise Limited (and reduced) as on...
Particulars Note No. `

I. Equity and Liabilities
(1) Shareholder's Funds
(a) Share Capital 1 6,36,000
(b) Reserves and Surplus 2 4,000
(2) Non-Current Liabilities
(a) Long-term borrowings 3 50,000
(3) Current Liabilities
(a) Other current liabilities 4 6,000

(b) Short-term provisions 5 24,000

Total 7,20,000
II. Assets
(1) Non-current assets
(a) Fixed assets
(i) Tangible assets 6 1,00,000
(2) Current assets
(a) Current investments
(b) Inventories 3,20,000
(c) Trade receivables 2,70,000
(d) Cash and cash equivalents 30,000
Total 7,20,000
Notes to Accounts
`
1. Share Capital
Equity Share Capital
Issued Capital : 53,600 Equity Shares of ` 10 each 5,36,000
Preference Share Capital
Preference Shares 1,00,000
(Of the above shares all are allotted as fully paid up pursuant
to capital reduction scheme by conversion of equity shares
without payment being received in cash)
6,36,000
2. Reserve and Surplus
Capital Reserve 4,000
Unsecured Loans
12% Debentures 50,000

4. Other current liabilities

Accrued interest 6,000
5. Short-term provisions
Provision for Income-tax 24,000
6. Tangible assets
Machineries 1,00,000
SUMMARY
1. Reconstruction is a process by which affairs of a company are reorganized by
revaluation of assets, reassessment of liabilities and by writing off the losses
already suffered by reducing the paid up value of shares and/or varying the
rights attached to different classes of shares.
2. Reconstruction account is a new account opened to transfer the sacrifice
made by the shareholders for that part of capital which is not represented by
lost assets.
3. Reconstruction account is utilized for writing-off fictitious assets, writing
down over-valued fixed assets, recording new liability etc.
4. If some credit balance remains in the reconstruction account, the same
should be transferred to the capital reserve account.
5. Methods of Internal reconstruction :
• Alteration of share capital :
 Sub-divide or consolidate shares into smaller or higher
Denomination
 Conversion of share into stock or vice-versa
• Variation of shareholders’ rights :
 Only the specific rights are changed. There is no change in the
amount of capital.
• Reduction of share capital
• Compromise, arrangements etc.
• Surrender of Shares.

TEST YOUR KNOWLEDGE

MCQs
1. When the object of reconstruction is usually to re-organise capital or to

compound with creditors or to effect economies then such type of
reconstruction is called
(a) Internal reconstruction with liquidation
(b) Internal reconstruction without liquidation of the company
(c) External reconstruction
2. The accumulated losses under scheme of internal reconstruction are written
off against
(a) Capital Reduction account
(b) Share Capital account
(c) Shareholders’ account
3. A process of reconstruction, which is carried out without liquidating the
company and forming a new one is called
(a) Internal reconstruction.
(b) External reconstruction.
(c) Amalgamation.
4. Reconstruction is a process by which affairs of a company are reorganized by
(a) Revaluation of assets and Reassessment of liabilities.
(b) Writing off the losses already suffered by reducing the paid up value of
shares and/or varying the rights attached to different classes of shares.
(c) Both (a) and (b)
Theoretical Questions
Question 1
What are the methods of internal reconstruction generally followed by
companies?

Practical Questions
Question 1
Green Limited had decided to reconstruct the Balance Sheet since it has accumulated
huge losses. The following is the summarized Balance Sheet of the Company on
31.3.20X1 before reconstruction:
Share Capital: Fixed Assets:
Authorised: Goodwill 20,00,000
1,50,000 Equity Shares of ` 50 75,00,000 Building 10,00,000
each
Subscribed and Paid up Capital: Plant 10,00,000
50,000 Equity Shares of ` 50 25,00,000 Computers 25,00,000
each
1,00,000 Equity Shares of ` 50 Investments Nil
each, ` 40 per share paid up 40,00,000 Current Assets Nil
Secured Loans: Profit and Loss 20,00,000
A/c-Loss
12% First Debentures 5,00,000
12% Second Debentures 10,00,000
Current Liabilities:
Trade payables 5,00,000
85,00,000 85,00,000
The following is the interest of Mr. X and Mr. Y in Green Limited:
Mr. X Mr. Y
` `
12% First Debentures 3,00,000 2,00,000
12% Second Debentures 7,00,000 3,00,000
Trade payables 2,00,000 1,00,000
12,00,000 6,00,000
Fully paid up ` 50 shares 3,00,000 2,00,000

Parly paid up shares (` 40 paid up) 5,00,000 5,00,000
The following Scheme of Reconstruction is approved by all parties interested and

also by the Court:
(a) Uncalled capital is to be called up in full and such shares and the other fully
paid up shares be converted into equity shares of ` 20 each.
(b) Mr. X is to cancel ` 7,00,000 of his total debt (other than share amount) and
to pay ` 2 lakhs to the company and to receive new 14% First Debentures for
the balance amount.
(c) Mr. Y is to cancel ` 3,00,000 of his total debt (other than equity shares) and to
accept new 14% First Debentures for the balance.
(d) The amount thus rendered available by the scheme shall be utilised in writing
off of Goodwill, Profit and Loss A/c Loss and the balance to write off the
value of computers.
You are required to draw the Journal Entries to record the same and also show
the Balance Sheet of the reconstructed company.
Question 2
The following is the summarised Balance Sheet of Weak Ltd. as on 31.3.20X1:
Equity shares of ` 100 each 1,00,00,000 Fixed assets 1,25,00,000
12% cumulative preference 50,00,000 Investments (Market 10,00,000

shares of ` 100 each value ` 9,50,000)
10% debentures of ` 100 40,00,000 Current assets 1,00,00,000

each
Trade payables 50,00,000 P & L A/c 6,00,000
Provision for taxation 1,00,000
2,41,00,000 2,41,00,000
The following scheme of reorganization is sanctioned:

(i) All the existing equity shares are reduced to ` 40 each.
(ii) All preference shares are reduced to ` 60 each.

(iii) The rate of interest on debentures is increased to 12%. The debenture holders
surrender their existing debentures of ` 100 each and exchange the same for
fresh debentures of ` 70 each for every debenture held by them.
(iv) One of the creditors of the company to whom the company owes ` 20,00,000
decides to forgo 40% of his claim. He is allotted 30,000 equity shares of ` 40
each in full satisfaction of his claim.
(v) Fixed assets are to be written down by 30%.
(vi) Current assets are to be revalued at ` 45,00,000.
(vii) The taxation liability of the company is settled at ` 1,50,000.
(viii) Investments to be brought to their market value.
(ix) It is decided to write off the debit balance of Profit and Loss account.
Pass Journal entries and show the Balance sheet of the company after giving
effect to the above.
Question 3
The following is the summarized Balance Sheet of X Ltd. as on 31st March, 20X1:
12,000, 10% Preference shares Goodwill 90,000
of ` 100 each 12,00,000
24,000, Equity shares of ` 100 24,00,000 Land & building 12,00,000
each
10% Debentures 6,00,000 Plant & machinery 18,00,000
Bank overdraft 6,00,000 Inventories 2,60,000
Trade payables 3,00,000 Trade receivables 2,80,000
Cash 30,000
Profit & Loss Account 14,40,000
51,00,000 51,00,000
On the above date, the company adopted the following scheme of reconstruction:
(i) The equity shares are to be reduced to shares of ` 40 each fully paid and the
preference shares to be reduced to fully paid shares of ` 75 each.
(ii) The debenture holders took over Inventories and Trade receivables in full
satisfaction of their claims.

(iii) The Land and Building to be appreciated by 30% and Plant and machinery to
be depreciated by 30%.
(iv) The debit balance of profit and loss account and intangible assets are to be
eliminated.
(v) Expenses of reconstruction amounted to ` 5,000.
Give journal entries incorporating the above scheme of reconstruction and
prepare the reconstructed Balance Sheet.
Question 4
The following scheme of reconstruction has been approved for Win Limited:
(i) The shareholders to receive in lieu of their present holding at 1,00,000 shares
of ` 10 each, the following:
(a) New fully paid ` 10 Equity shares equal to 3/5th of their holding.
(b) 10% Preference shares fully paid to the extent of 1/5th of the above new
equity shares.
(c) ` 40,000, 8% Debentures.
(ii) An issue of ` 1 lakh 10% first debentures was made and allotted, payment for
the same being received in cash forthwith.
(iii) Goodwill which stood at ` 1,40,000 was completely written off.
(iv) Plant and machinery which stood at ` 2,00,000 was written down to `
1,50,000.
(v) Freehold property which stood at ` 1,50,000 was written down by ` 50,000.
You are required to draw up the necessary Journal entries in the Books of Win
Limited for the above reconstruction. Suitable narrations to Journal entries
should form part of your answer.
ANSWER/HINTS
MCQs
[1. (b), 2. (a), 3. (a), 4. (c)]
Theoretical Questions
1. Methods of Internal reconstruction :

• Sub-division or consolidation of shares into smaller or higher
Denomination and Conversion of share into stock or vice-versa

• Variation of shareholders’ rights :
• Reduction of share capital
• Compromise, arrangements etc.
• Surrender of Shares.
Practical Questions
Answer 1
Green Limited
Journal Entries
Dr. Cr.
` `
Bank Account Dr. 10,00,000
To Equity Share Capital Account 10,00,000
(Balance of ` 10 per share on 1,00,000 equity shares
called up as per reconstruction scheme)
Equity Share Capital Account (` 50) Dr. 75,00,000
To Equity Share Capital Account (` 20) 30,00,000
To Capital Reduction Account 45,00,000
(Reduction of equity shares of ` 50 each to
shares of ` 20 each as per reconstruction scheme)
12% First Debentures Account Dr. 3,00,000
12% Second Debentures Account Dr. 7,00,000
Trade payables Account Dr. 2,00,000
To X 12,00,000
(The total amount due to X, transferred to
his account)
Bank Account Dr. 2,00,000
To X 2,00,000
(The amount paid by X under the reconstruction
scheme)

12% First Debentures Account Dr. 2,00,000

12% Second Debentures Account Dr. 3,00,000
Trade payables Account Dr. 1,00,000
To Y 6,00,000
(The total amount due to Y, transferred to
his account)
Y Dr. 6,00,000
To 14% First Debentures Account 3,00,000
(The amount due to Y discharged by issue of
14% first debentures)
X Dr. 14,00,000
To 14% First Debentures Account 7,00,000
(The cancellation of ` 7,00,000 out of total debt of
Mr. X and issue of 14% first debentures for the balance
amount as per reconstruction scheme)
Capital Reduction Account Dr. 55,00,000
To Goodwill Account 20,00,000
To Profit and Loss Account 20,00,000
To Computers Account 15,00,000
(The balance amount of capital reduction account utilised in
writing off goodwill, profit and loss account, and computers
Working Note
Balance Sheet of Green Limited (and reduced) as on
31st March, 20X1
Particulars Notes `

Total 42,00,000
Assets
a Fixed assets
2 Current assets
Cash and cash equivalents 12,00,000
Total 42,00,000
Notes to accounts
`
1. Share Capital
1,50,000 equity shares of ` 20 each 30,00,000
Total 30,00,000
Secured
14% First Debentures 10,00,000
Total 10,00,000
3. Tangible assets
Building 10,00,000
Plant 10,00,000
Computers 10,00,000
Total 30,00,000

Working Note:
` `
To Goodwill A/c 20,00,000 By Equity Share Capital A/c 45,00,000
To P & L A/c 20,00,000 By X 7,00,000
To Computers (Bal. Fig.) 15,00,000 By Y 3,00,000
55,00,000 55,00,000
Answer 2
Journal Entries in the books of Weak Ltd.
` `
(i) Equity share capital (` 100) A/c Dr. 1,00,00,000
(Being conversion of equity share capital of
` 100 each into ` 40 each as per reconstruction
scheme)
(ii) 12% Cumulative Preference Share capital 50,00,000
(` 100) A/c Dr.
To 12% Cumulative Preference Share 30,00,000
Capital (` 60) A/c
(Being conversion of 12% cumulative preference
share capital of ` 100 each into ` 60 each as per
(iii) 10% Debentures A/c Dr. 40,00,000
(Being 12% debentures issued to 10%
debenture-holders for 70% of their claims. The
balance transferred to capital reduction account
as per reconstruction scheme)

(iv) Trade payables A/c Dr. 20,00,000

To Equity Share Capital A/c 12,00,000
(Being a creditor of ` 20,00,000 agreed to
surrender his claim by 40% and was allotted
30,000 equity shares of ` 40 each in full
settlement of his dues as per reconstruction
scheme)
(v) Provision for Taxation A/c Dr. 1,00,000
Capital Reduction A/c Dr. 50,000
To current assets(bank A/c) A/c 1,50,000
(Being liability for taxation settled)
To P & L A/c 6,00,000
To Fixed Assets A/c 37,50,000
To Current Assets A/c 55,00,000
To Investments A/c 50,000
(Being amount of Capital Reduction utilized in
writing off P & L A/c (Dr.) Balance, Fixed Assets,
Current Assets, Investments through capital
reduction account)
(vii) Capital Reduction A/c Dr 50,000
To capital Reserve A/c 50,000
(Being balance in capital reduction account
transferred to capital reserve account)
Balance Sheet of Weak Ltd. (and reduced) as on 31.3.20X1
Particulars Notes `
b Reserves and Surplus 2 50,000

Total 1,40,50,000
Assets
a Fixed assets
b Investments 5 9,50,000
2 Current assets 6 43,50,000
Total 1,40,50,000
Notes to accounts
`
1. Share Capital
1,30,000 equity shares of ` 40 each 52,00,000
50,000 12% Cumulative Preference shares of
30,00,000
` 60 each
Total 82,00,000
Secured
4. Tangible assets
Fixed Assets 1,25,00,000

5. Investments 10,00,000
Adjustment under scheme of reconstruction (50,000) 9,50,000
6. Current assets 45,00,000
Working Note:
` `
To Current Asset 50,000 By Equity share capital 60,00,000
To P & L A/c 6,00,000 By 12% Cumulative 20,00,000
preference share
capital
To Fixed assets 37,50,000 By 10% Debentures 12,00,000
To Current assets 55,00,000 By Trade payables 8,00,000
To Investment 50,000
To Capital Reserve (bal. fig.) 50,000
1,00,00,000 1,00,00,000
Answer 3
In the books of X Ltd.
Journal Entries
31st March, 20X1 ` `

(i) Equity Share Capital A/c (` 100) Dr. 24,00,000
To Equity Share Capital A/c (` 40) 9,60,000
(Being 24,000 equity shares of ` 100 each
reduced to ` 40 each fully paid up)
(ii) 10% Preference Share Capital A/c (` 100) Dr. 12,00,000
To 10% Preference Share Capital A/c (` 75) 9,00,000
(Being 12,000 Preference shares of ` 100 each
reduced to ` 75 each fully paid up)
(iii) 10% Debentures A/c Dr. 6,00,000
To Inventories A/c 2,60,000
To Trade receivables A/c 2,80,000

(Being debenture holders given Inventories and
Trade receivables in full settlement of their
claims)
(iv) Land & Building A/c Dr. 3,60,000
(Being Land & Building appreciated by 30%)
(v) Capital reduction A/c Dr. 5,000
To Cash A/c 5,000
(Being expenses of reconstruction paid)
To Goodwill A/c 90,000
To Profit and Loss A/c 14,40,000
To Plant & Machinery A/c 5,40,000
(Being various losses written off, assets written
down through Capital Reserve A/c )
(vii) Capital Reduction Dr. 85,000
To Capital Reserve A/c (Bal. Fig.) 85,000
(Being balance in Capital Reduction A/c
transferred to Capital Reserve A/c)
Balance Sheet (And Reduced) of X Ltd.

as at 31st March, 20X1
Particulars Notes No. `

b Reserves and Surplus 2 85,000

b Short term borrowings 6,00,000

Total 28,45,000
Assets
a Fixed assets
2 Current assets
Cash and cash equivalents (30,000 -5,000) 25,000
Total 28,45,000
Notes to accounts
`
1. Share Capital
24,000 equity shares of ` 40 each fully paid up 9,60,000
12,000, 10% Preference shares of ` 75 each
9,00,000
fully paid up
Total 18,60,000
3. Tangible assets
Land and Building 15,60,000
Plant and Machinery 12,60,000
Total 28,20,000
Answer 4
Journal Entries
` `
Equity Share Capital (old) A/c Dr. 10,00,000
To 10% Preference Share Capital A/c 1,20,000
To 8% Debentures A/c 40,000


(Being new equity shares, 10% Preference
Shares, 8% Debentures issued and the balance
transferred to Reconstruction account as per
the Scheme)
Bank A/c Dr. 1,00,000
To 10% First Debentures A/c 1,00,000
(Being allotment of 10% first Debentures)
Capital Reduction A/c Dr. 2,40,000
To Goodwill Account 1,40,000
To Plant and Machinery Account 50,000
To Freehold Property Account 50,000
(Being Capital Reduction Account utilized for
writing off of Goodwill, Plant and Machinery
and Freehold property as per the scheme)

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CHAPTER 7

Sub-division and Conversion of share

© The Institute of Chartered Accountants of India

Reconstruction is a process by which affairs of a company are reorganized by

However, there may be external reconstruction. Wherever an undertaking is being

Difference Between Internal and External Reconstruction

Basis Internal Reconstruction External Reconstruction

© The Institute of Chartered Accountants of India

Legal position Internal reconstruction is External reconstruction is

2. METHODS OF INTERNAL RECONSTRUCTION

2.1 Alteration of Share Capital

Similar entries will be passed on consolidation of shares of a smaller amount into

© The Institute of Chartered Accountants of India

On 31-12-20X1, B Ltd. had 20,000, ` 10 Equity Shares as authorised capital and

Notes to Balance Sheet

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

2.2 Variation of Shareholders Rights

© The Institute of Chartered Accountants of India

(b) Debit …% Cum. Pref. Share Capital Account

This reduction is a sacrifice by the shareholders and the amount of reduction or

Share Capital (Partly Paid-Up) Account Dr. (` 7.5 X No. of Shares)

To Share Capital (Fully Paid-up) Account (` 7.5 X No. of Shares)

© The Institute of Chartered Accountants of India

Share Capital Account (` 10 ) Dr. (` 10 X No. of Shares)

To Bank Account (` 2 X No. of Shares)

Share Capital Account Dr. (` 90 X No. of Shares)

Accounting treatment for some of the cases is as follows:

© The Institute of Chartered Accountants of India

b) Settlement of outside liabilities at lesser amount: Liabilities such as sundry

2.5 Surrender of Shares

3. ENTRIES IN CASE OF INTERNAL RECONSTRUCTION

The Court approved a Scheme of re-organisation to take effect on 1-1-20X1,

© The Institute of Chartered Accountants of India

Journal of A & Co. Ltd.

© The Institute of Chartered Accountants of India

6% Cum. Preference Share Capital A/c Dr. 4,00,000

To Equity Share Capital A/c 90,000

© The Institute of Chartered Accountants of India

b Short term provision 3 68,500

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

Particulars Debit Credit

© The Institute of Chartered Accountants of India

To Capital reduction A/c 7,12,500

To Plant A/c 35,000

Balance sheet of Rebuilt Ltd. (and reduced)

65,000 Preference shares of ` 10 each 6,50,000

© The Institute of Chartered Accountants of India

The following scheme of reconstruction is proposed:

Particulars Debit Credit

Second debentures A/c Dr. 3,00,000

1. Settlement of claim of remaining unsecured creditors `

75% of ` 3,00,000 2,25,000

© The Institute of Chartered Accountants of India

2,25,000/60 =3,750 shares

2. Ascertainment of profit and loss account’s debit balance at the time of

© The Institute of Chartered Accountants of India

The following scheme of Internal Reconstruction is sanctioned:

Journal Entries in the books of Vaibhav Ltd.

(iii) 5% Debentures (` 100) A/c Dr. 80,00,000

© The Institute of Chartered Accountants of India